5 Tax Lessons for Business Owners from a Financial Planner
5 Tax Planning Lessons that you need to know if you run your own business.
We know CRA always wants to have a piece of what we earn, so here are 5 strategies that you need to know to reduce taxes and maximize your wealth as a small business owner in British Columbia.
#1. Dividends vs. Salary
Canada's Tax Code Integrates their tax rates, so taking dividends and taking a Salary results in a very similar tax rate for all business owners. Taking Salary allows you to qualify for CPP contributions up to the Yearly Maximum Pensionable Earnings amount - why is this important? By contributing to Canada Pension Plan each year, you will be eligible for guaranteed benefits in retirement in the amount of $1,253 per month (in 2022). In addition, this retirement benefit is indexed with inflation each year resulting in this benefit rising each year to match the cost of living. Salary income also counts as active income which qualifies you to generate 18% of your income in the form of RRSP contribution room.
On the other hand, taking dividends from a small business in Canada does allow for a slight relief in that CPP contributions won't be due on these funds. Dividend income is seen as passive income which does not qualify for CPP contributions and is also excluded in the calculation of RRSP contribution room.
#2. Income Splitting to Reduce Overall Taxes.
Often times, small business owners end up becoming the sole breadwinners of the family. In such a situation, it makes alot of sense to have your partner/spouse become a shareholder in your business so you can split the total receivers of income from the company. This is called Income Splitting and is a legitimate strategy that allows for business owners and their family members to take advantage of Canada's progressive tax rates (ie., the less you report, the less you are taxed. The more you report, the more you are taxed).
#3. Incorporating your business is not always the best tax planning strategy.
If you withdraw 100% of your funds from your corporation every year, then there is no reason to be incorporated. However, it makes a lot of sense to incorporate if you leave money in your corporation for reinvestment purposes or just to accumulate cash savings since these funds are only taxed at the small business rate (12% under $500,000) resulting in any reinvestment or savings to happen in "pre-tax" dollars.
While incorporating does provide some level of liability protection, most times in solely held corporations the legal system could allow for the plaintiff to bypass the corporate veil and hold the sole owner personally liable.
#4. Risk Management
As a business owner, your most valuable asset is your ability to generate an income for the business. Often times you are not covered by EI or Workers Compensation Board benefits - even if you are, the coverage often takes effect only when you are "on-the-job". Therefore, its important to look at coverage that will protect your livelihood on the off chance that you are disabled or become seriously sick. Considering a basic level of extended health & dental coverage often provides for a very good starting point as premiums could be tax deductible and you often get more out of the plan than you pay!
Disability coverage that specializes in injury along with sickness & accident coverage for minimal prices are ideal - most insurers dislike covering business owners as its often hard to pin down their income however, working with specialized providers will often get you the best value for your dollar.
#5. Advanced Estate Planning Strategies
This is for the business owners who are looking to transfer wealth to their successors, family or children in the future. You can use corporate savings meant to be given to your next-of-kin to fund Corporate Insurance Plan where your insurance premiums paid into the policy result in 4 to 7 times the amount in the form of a death benefit.
Over the life of the insurance policy, there is investment growth that build up within these plans which can be used as collateral for a loan should you need to access the capital that has been deposited.
Upon death, proceeds from the policy will be paid out tax free to the corporation after any outstanding loan balances have been wiped out and the corporation would pay these funds out in the form of a Capital Dividend to the final beneficiaries tax-free.
Of course, these strategies all require that you bring on a financial planning or accounting professional to execute properly so as to make sure you fall in line with CRA's tax regulations, even if you're looking to take advantage of them!
Happy To Chat if You're Willing.
Clement Chung, CFP, CLU Certified Financial Planner